Forecast for 2019

Well, there has not been a year starting like this for a long time. The US government is in disarray. The President of the Unites States starts the second half of his four-year term having lost his majority in the lower house of Congress to the Democrats in a heavy polling defeat last November. He starts with an acting chief of staff, an acting secretary of defense, an acting attorney general, an acting EPA administrator, no interior secretary and no ambassador to the UN. His former campaign manager, deputy campaign manager, national security adviser and personal lawyer have all pleaded guilty to criminal offences. And the investigation by special prosecutor Mueller on the connections between the Trump presidential campaign and Russian intelligence will be stepped up. Meanwhile, one-quarter of government departments are closed because of Trump’s budget fight with Congress.

Also the geopolitical environment has turned toxic. The Trump administration has picked a fight with China over trade and technical know-how that threatens to intensify when the current ‘pause’ on the tit-for-tat trade tariffs ends in March.

This time last year, Trump was boasting that the US economy was booming, with record highs for the US stock market. Back then, I said that “What seems to have happened is that there has been a short-term cyclical recovery from mid-2016, after a near global recession from the end of 2014-mid 2016. If the trough of this Kitchin cycle was in mid-2016, the peak should be in 2018, with a swing down again after that.”

And in April 2018, I posted that I thought the short boom in 2017 from the mini-recession of 2015-6 was over and that world growth had peaked. And so it has proved. 2018 has ended with real GDP growth starting to slow nearly everywhere.

And at the end of 2018, stock markets suffered the deepest fall since the global financial crash in 2008. Current US treasury secretary Mnuchin panicked and called a meeting of the top six US banks on Xmas eve to check that they were confident of standing firm, only making things worse.

As I have argued before, Marx said that what drives stock market prices is the difference between interest rates and the overall rate of profit. What has kept stock market prices rising since 2009 has been the very low level of long-term interest rates, deliberately engendered by central banks like the Federal Reserve around the world, with zero short-term rates and quantitative easing (buying financial assets with credit injections). The gap between returns on investing in the stock market and the cost of borrowing to do so has been high.

But in 2018 investors in fictitious capital (stocks and bonds) perceived that this situation was changing. Interest rates are on the rise (driven by the US Fed) and there are signs that the recovery in the rate of return on capital in the major economies has peaked and is reversing. US growth peaked in Q2 at a 4% annual rate and Q4 growth is expected to be closer to 2.5%. The very latest indicator of US growth, the Richmond business activity indicator, suggests a sharp drop in growth in early 2019 – perhaps even to stagnation.

In Europe, hopes of a synchronised expansion matching that of the US have been dashed, as the leading European economies, France and Germany, have slowed, while the weaker ones like Italy have slipped back into recession. UK real GDP growth is also dropping fast as companies apply an investment strike due to uncertainty over Brexit. The Eurozone economy is now growing at only 1.6% compared to nearly double that rate this time last year.

And it is not just in the major advanced capitalist economies that the forecast end to the Long Depression since 2008 has been confounded. In Asia too, there has been a slowdown in the second half of 2018. Japan’s real GDP was static in Q3 2018.

The world’s largest manufacturing economy, China, has also slowed.

Korea too is slowing.

All the official growth forecasts (from the IMF, the OECD, World Bank etc) for are for a lower rate in 2019 compared to 2018.

Now a recession in mainstream economics is technically defined as two consecutive quarterly contractions in real GDP growth. The consensus does not expect that in 2019. But are the mainstream experts wrong; will the major economies drop into a slump this coming year?

So what now for 2019? Well, what did I say were the key factors for 2018? I said that “there are two things that put a question mark on the delivery of faster growth for most capitalist economies in 2018 and raise the possibility of the opposite. The first is profitability and profits” and the second “is debt…global debt, particularly private sector (corporate and household) debt has continued to rise to new records.”

This is still true for 2019. Global debt rose through 2018 and, most important, the cost of servicing that debt also began to rise as the US Federal Reserve continued with hiking its policy rate – with the last rise made just before the end of the year.

The Fed rate sets the floor for interest rates in the US and also the benchmark for international rates, given the dominant role of the dollar in international reserves and capital flows. And other central banks have ended their cheap money injections – quantitative easing – which has now turned into quantitative tightening.

Thus “financial conditions” (the cost of debt, the state of stock markets and the value of the dollar against other currencies) have been tightening.

Just after Janet Yellen ended her term as Federal Reserve chair (her term was not renewed by Trump because he said she was “too short”), she declared that “there would be no more financial crises in our lifetime”, because of the new measures applied to ensure the banks won’t crash again. But last month, she revised that view. Apparently, there are “gigantic holes in the financial system” that she presided over and she now worries that “there could be another financial crisis” after all. This is because financial regulation is ‘unfinished” and she is not sure that the Fed and government are doing anything about that “in the way we should”.

In a recent paper, Carmen Reinhart, a mainstream expert on the history of financial crises, drew attention to the sharp rise in unbacked corporate debt, called leveraged loans, with issuance hitting record highs in 2018. Reinhart concluded that “the networks for financial contagion, should things turn ugly, are already in place.”

The Bank for International Settlements (BIS), the international research agency for central banks, warned that what it calls the ‘financial cycle’ implies that a new credit crunch is coming. “Financial cycle booms can end in crises and, even if they do not, they tend to weaken growth. Once financial cycles peak, the real economy typically suffers. This is most evident around financial crises, which tend to follow exuberant credit and asset price growth, ie financial cycle booms. Crises in turn tend to usher in deep recessions, as falling asset prices, high debt burdens and balance sheet repair drag down growth.” And most important “the debt service ratio is particularly effective in this aspect”.

All the credit indicators for a recession are now flashing amber, if not red. The most popular is the so-called inverted yield curve, namely when the interest rate on a long-term government bond falls below the Federal Reserve’s policy rate. Whenever that happens, it nearly always indicates a recession within a year. Why? Because what the inverted curve tells us is that investors think that a slump is coming so they are buying ‘safe assets’ like government bonds, while the Fed thinks the economy is fine and is hiking rates – but the market will decide.

As one analyst put it: “Think of an inverted yield curve as a fever. When your body gets a fever, the fever is not the cause of the sickness. It just says something’s wrong with your body. You have the flu, appendicitis, or some other ailment. The fever indicates you are sick but not necessarily what the sickness is. And typically, the higher the fever, the more serious the condition. It is the same with the yield curve. The more inverted the yield curve is and the longer it stays that way, the more confident we are that something is economically wrong that may show up as a recession sometime in the future.” The US yield curve has flattened but has not yet inverted. So this reliable indicator has still not turned red yet.

Another important indicator for a coming recession can be found, not in the credit markets, but in the global economy. It’s the price of copper and other industrial metals. Metals are central inputs in industrial production around the world and so if their prices fall, this suggests that companies are reducing investment in production and so using less metal components.

In 2018, the copper price fell back from a peak of 320 to 270 after July. But since then it has steadied and remains well above 200 then it fell to in the mini-recession of early 2016. So this suggests that while the world economy peaked back last summer, a recession is not yet with us.

Another indicator that the world economy is slowing down from its mini-boom in 2017 is the sharp fall in oil prices. The price has plunged from $75/b in October to $45/b now. That will hit the profits of the energy companies and the trade balances of the oil producers.

The most important factor for analysing the health of the capitalist economy remains the profitability of the capitalist sector and the movement in profits globally. That decides whether investment and production will continue. This blog has presented overwhelming evidence that profits and investment are highly correlated and in that order – see our latest book, World in Crisis.

The US corporate sector ended 2018 with record levels of profits/earnings, rising some 20%, the highest rate since 2010, when the US economy rebounded from the Great Recession. But this profit jump was a one-off. It’s been driven by huge corporate tax cuts and exemptions from tax in repatriating cash reserves from abroad that the major US companies held. And US corporate revenues have been boosted by a very sharp fall in input costs, namely the fall in the oil price during 2018.

Globally, profits were still growing in the middle of 2018. But profits growth has slowed in Germany, China and Japan. Only the US has experienced any acceleration. And if the US profits growth is a one-off, as argued above, global profits growth is likely to fall away sharply in 2019.

Slowing profits growth and a rising cost of (corporate) debt, alongside all the politico-economic factors of an international trade war between China and the US, suggest that in 2019 the likelihood of a global slump has never been higher since the end of the Great Recession in 2009.

20 Responses to “Forecast for 2019”

“But in 2018 investors in fictitious capital (stocks and bonds) perceived that this situation was changing”

1. Why are stocks and bonds “fictitious capital”? If company issues a security instrument, and uses the proceeds of that to expand production, employ more labor power, build another factory, is the instrument a fictitious instrument but the underlying assets are “non-fictitious”?

It’s a nonsense distinction. The issue is not whether or not fictitious capital exists. The point rather is that ALL capital, paper or hard asset, becomes “fictitious” when it cannot return a profit quickly, and massively enough.

“And it is not just in the major advanced capitalist economies that the forecast end to the Long Depression since 2008 has been confounded. In Asia too, there has been a slowdown in the second half of 2018. Japan’s real GDP was static in Q3 2018.”

2. Must be a syntax error. Obviously, Michael, you know Japan is a major advanced capitalist economy.

You’re talking about two capitals here. Company X emits paper C and sells it in the financial market or whatever for a quantity of money(-capital) M, then, by chance, employs it productively:

C — M — C — …P… — C’ — M’

But investor Y still has the papers in his hand, as fictitious (financial) capital:

M — C (the inverse of the first part of the first case)

He can either wait for the paper to rise in price:

M — C — M’

In which case, it was money that gave birth to money — fictitious capital.

Or, he can receive dividends proportional if the company turned out a profit:

M — C — M’

So, the same equation of fictitious capital.

In the dividends’ case, the only thing that would change would be from the point of view of the company, which would’ve to subtract from its surplus value (M’) the interest from the owner of the paper:

[…]M’ – J

The result would be what Marx denominated “entrepreneur’s profit” (I directly translated from the Portuguese version — in English I think it was translated as “profit of enterprise”): the profit of the productive capital minus what is due to the “financial” capitalist.

Either way, the paper is fictitious capital, because the paper, obviously, is fiat, so it would follow the general “formula” of interest-bearing capital: M — M’ (money which generates money).

There is no C in relation to fictitious capital. As Marx demonstrates in Capital III, it exists outside the circuit of industrial capital. It is fictitious for the simple reason that it cannot autonomously self-expand.

Its expansion M-M` is only possible, because it appropriates a portion of the surplus value created by industrial capital.

Fictitious capital can experience capital gains/losses as distinct from profits/losses, because of the movement in the prices of the assets that constitute the fictitious capital. As revenue producing assets, their price, as with the price of land is determined by the capitalised value of their revenues.

So, if the rent produced by a hectare of land is £100, and the rate of interest is 5%, the capitalised value of the rent is 100 x 100/5 = £2000, i.e. £2000 of capital is required to produce a revenue of £100 p.a. The same with shares or bonds. A bond with a coupon of £100, with a market rate of interest of 5%, has a value of £2000, and the same for a share that produces £100 in dividends. In practice these prices are also adjusted for risk.

If the revenue produced by an asset rises, for example if demand for land pushes up rents, then the capitalised value of the land, its price, rises accordingly. If dividends rise, then share prices rise. Provided there is no change in the market rate of interest.

If the revenues produced by these assets remain constant, but the market rate of interest rises, then the capitalised values will correspondingly fall. For example, if rates go to 10%, the capitalised value of these assets would fall to £1000, because with a 10% rate of interest, only £1,000 of loanable money-capital is required to produce £100 p.a. in revenue.

That is why, as Marx sets out in Capital III, it is changes in these market rates of interest that tend to have the biggest effects on asset prices. Moreover, the lower the actual market rate of interest in absolute terms, the greater the effect, any absolute change in rates has, because it represents represents a bigger proportional change.

For example, if interest rates are 1%, then the capitalised values above, would be £10,000. If now we assume the same doubling of rates, it requires only a 100 point rise, from 1% to 2%, and this would cause asset prices to fall to £5,000. If as originally the interest rate rises by 500 points, that would be from 1% to 6%, and asset prices would fall from £10,000 to £1600!

If you look at the chart of the Dow Jones between 1965-1985 in inflation adjusted terms, you will see that it actually falls. This was a time of rising interest rates. Between 1950 and 1980, the Dow rose by only half as much as the rise in US GDP. By comparison, in the period between 1980 and 2000, the Dow rose by around 6 times the rise in US GDP. That was a time when interest rates were falling.

So, as global interest rates are rising again, a process that started prior to the 2008 crash, its no wonder that we see asset prices falling again. Given that the dominant sections of the capitalist class now hold the vast majority of their wealth in the form of fictitious capital rather than as productive-capital, its also no wonder that from the moment of the first scare with the 1987 crash, we saw the implementation of the Greenspan Put, and that after 2008, we saw an intensified campaign by central banks to reflate the prices of that fictitious capital at the expense of real capital, via the use of QE to directly buy up those worthless paper assets, and to hold back the rise in interest rates, by implementing policies of austerity to slow global growth, and thereby restrain the growth in the demand for money-capital, whilst further encouraging money away from real investment into financial and property speculation.

VK concludes: “Either way, the paper is fictitious capital, because the paper, obviously, is fiat, so it would follow the general “formula” of interest-bearing capital: M — M’ (money which generates money).”

That’s like telling me paper money is fictitious because it’s paper, whereas a commodity represents value. The truth is in grasping that money represents value “in its heavenly state,” detached from the particular, earthly forms of any or all commodities.

The credit and debt instruments have their origin in the uneven turnover periods of the various capitals and serve to reconcile those differences by making portions of the total surplus value extracted liquid, accessible to capitalists in the interim between production and realization.

The bonds used to finance Maersk’s EEE class container ships are not fictitious capital no matter how many times they exchange hands in secondary markets. No matter who owns them. They represent a claim on the surplus value that precipitates into Maersk accounts through maritime shipping. The claim is grounded in, and seizes upon, the instruments of production to guarantee itself.

“Money giving birth to money” is an appearance, and only an appearance. The interest on the debt instrument is derived from surplus value. The interim circuits might be obscured, but those interim circuits still govern.

I don’t think it makes much sense to claim that the “dominant sections of the capitalist class now hold the vast majority of their wealth in the form of fictitious capital rather than as productive-capital” for a number of reasons a) it seems to be a claim based purely on the notional value equity, debt, and credit instruments and their derivatives rather than any actual connection to who owns what and how, i.e. what portion is in cash, what portion is in real property, what portion is in publicly traded shares, what portion is in restricted shares, etc. b) the valuations may and do change, but the OWNERSHIP does not change with the transition to holdings in paper. The capitalists as a class own the means of production, all the means of production. The holdings in paper are a matter of convenience and flexibility, not false ownership c) any and everything under capital can be securitized. Is a deed to a property fictitious, or more fictitious than the property itself? Property, under capital, exists to be exchanged, to be transformed into an exchange value. There’s no way to do that without creating instruments of exchange. That’s what these instruments are.

I think we should, as Marx did, sharply distinguish between the paper held by capitalists and the underlying asset. If the relation between the two was fixed then some of your statements would be valid. However they are elastic (mulitples change) which makes the paper speculatible. Today, the statement that the wealth is paper based is not due to this primary paper, but the secondary paper sitting on top of it, derivatives, which have blossomed since the 1980s diluting returns and creating a crisis for pension and insurance companies.

The “distinction” between paper and asset becomes “sharp” or “acute” under and during specific conditions, and is not sharp nor acute under other conditions. Those conditions have everything to do with process, and impairment to the process of capital accumulation. While the deviation is made possible by the distinction between the paper instruments and the assets, the distinction itself represents nothing more than the distinction between the particular form of a commodity and the universal form of exchange value, money.

Of course there’s elasticity. Elasticity is required. Price is the “elastic” deformation of value for every one of capital’s commodities, hard asset or paper representation.

Is it possible for the bourgeoisie to claim ownership or “hard assets” separate and apart from the paper representation? It isn’t, and never has been possible. Value has to be exchangeable. The ownership of value has to be transferable. Stocks, deeds, etc. are carriers of value. If the value deteriorates, if the reproduction of value is impaired, if the circulation of value falters, then these paper carriers mirror that deterioration.

Is the paper subject to speculation? Of course it is, just as every commodity produced under capitalism is subject to speculation. There, after all, grain markets, metal exchanges, petroleum markets where the price of the commodity is the product of speculation. That money can be made in this speculation doesn’t mean that the speculation is distinct from, in opposition to, the actual production of value itself. The speculation is intrinsic to the realization of value.

Wealth is paper based not due to the “primary paper”, but due to the “secondary paper”? Because the notional value of options, futures, credit default swaps etc. is so much greater than the notional value of stocks and bonds? Maybe. But the “secondary paper” represents trading positions, not hoards of wealth. In the accumulation of wealth, the bourgeoisie have a distinct minority of their personal wealth and holdings tied up in this “secondary paper,” in these derivatives. Real estate probably makes up a greater portion of that wealth than secondary paper.

“Fictitious capital” does not account for, or explain, the real expansion of the post WW2 capitalist economy to 1973, the slowing growth after 1973, the double-dip recession of the 1980s, the movement of oil prices 1973-2018, the “acceleration” in the US 1993-2000, the 2001 recession (no the collapse of the dot.com bubble did not cause that recession), the 2004-2007 recovery. Speculation accompanies all these movements, because speculation accompanies all movements of capital.

The conflict within capitalism is not between “non-productive” or finance, or fictitious capital, and “productive,’ industrial, hard asset capital. It, the conflict, remains as it always has been– between labor and the conditions of that labor; between the production process and the valorization process. When the “paper” is reduced to its use value as paper, it is only because capital has precipitated, as it always does, a self-devaluation of its relations of production, including assets hard and soft.

” If the relation between the two was fixed then some of your statements would be valid.”

Who is the “you” here that you are referring to?

The nature of the wealth as paper, fictitious wealth is not solely attributable to the secondary paper, i.e. derivatives, but die to the fact that the paper – the share, bond, loan certificate, mortgage etc. is not capital. In fact, in Capital III, Engels discusses derivatives as they had already developed in his day, for example in the form of Unit Trusts.

The mortgage is the clearest example of the actual relation. A bank that lends money on a mortgage for you to buy a house, does not own the house you buy with it. They do not have the right to tell you how to use the house, who to rent it to, or to acquire that rent, or to any capital gains resulting from an inflation in the market price of the house. The bank owns not the house, but the money they lent to you, which they have a right to get back with interest.

The same applies to a bank that gives you a business loan. They never give up ownership of the money they lend, and do not thereby obtain ownership of any asset, or productive capital you buy with the money loaned. They give up possession of the money-capital for a determined period, and thereby as Marx and Engels explain, they sell to you the use value of that money-capital, its ability to obtain the average rate of profit. The interest charged is the price of this use value they have sold to you.

The same applies to commercial bonds. The money loaned to a company via the issuance of commercial bonds, is not different to the money loaned to a company via the issue of shares. These are simply different debt instruments. The owner of the share, bond, mortgage or loan certificate is not the owner of any assets bought with the borrowed money. They are only owners of shares, bonds, mortgages etc. They have a right to dispose of those pieces of paper as with any other property in their ownership, but not the property bought with the loaned money, which does not belong to them, any more than the bank has a right to tell you what colour to paint your living room.

The fact that shareholders – and even then not all shareholders – have a right to appoint Directors, and vote at shareholders meetings – whereas bondholders don’t – is an anachronism that has no foundation in law or economics. The owners of the paper assets are entitled to the market rate of interest on them, and nothing more. It is the political power of the owners of the shares that has enabled them to hold on to that unjustified influence. Though in Germany it has been constrained partly by the co-determination laws.

Even the theorists and pundits of bourgeois property law and rights recognise that. For example 20 years ago, the FT’s John Kay, along with Aubrey Silberston set out why shareholders in BT do not own BT’s productive-capital, and have no more right to control it than does BT’s landlords who lend land and buildings to it, rather than money.

“The nature of the wealth as paper, fictitious wealth is not solely attributable to the secondary paper, i.e. derivatives, but die to the fact that the paper – the share, bond, loan certificate, mortgage etc. is not capital.”

These instruments are used to distribute and apportion surplus value, but they are not capital. They do not engage wage-labor, unless they are liquidated into money and advanced to purchase the wage-labor and instruments of production. These instruments may represent capital, may make claims on capital, but they do not exist as capital, no more than interest payments are “capital.”

Not capital, and not “fictitious” but real expressions of private property.

The data shows, as I predicted last year that the three year cycle would cause a relative slowing of growth between 2017 Q3, and the end of Q3 2018. The main factor causing current weakness, is the effect of Trump’s global trade war, retaliation and Brexit. Trump’s tariffs are reckoned to have taken 0.3% off China’s growth, for example.

You are quite right that for the last ten years (actually the last 30, following the start of the Greenspan Put in 1987) that it became more lucrative to obtain capital gains from speculation in fictitious capital (shares, bonds property) rather than invest in real productive-capital, on the basis of obtaining profits. You are quite right that that trend is reversing because interest rates are rising, and central banks have run out of road to print money to buy up financial assets.

At the same time profits are getting squeezed, because employment is rising, and wages are rising. Growing employment and wages is increasing the demand for wage goods, often today in the form of services – for, example, the current story about HMV, because today nobody buys CD’s or videos, but instead streams them from Netflix etc. – which means that, to meet this increased demand, more labour is required to provide these services.

As demand drives capital accumulation, because firms have to compete to obtain their share of this rising demand, or at least not lose market share, that drives up the demand for money-capital relative to supply , pushing up interest rates, and reducing the capitalised prices of fictitious capital.

As money, thereby flows out of speculation in fictitious capital, and goes into the real economy, then if Trump’s trade war is removed, and if Brexit is resolved, this short term effect on trade and growth will be removed. If the trade wars continue growth will be less than it would have been, but will get channelled differently, as a result of import substitution. It will also push up costs, and reduce productivity, which with money moving out of fictitious capital into real capital will cause inflation to rise, causing nominal interest rates to rise further.

Incidentally, as Marx says, central banks cannot at all determine market rates of interest, which is determined by the demand and supply for money-capital. They can only affect the prices of certain financial assets, such as government bonds.

Too modest by half. Boffy also predicted the return of growth to the EU in the 4Q 2018, as the beginning of another uptick that would last through 2019, claiming to see signs of returning growth in July, or August, or whatever PMI numbers. That was then.

This is now.

Now we get hedging,– “if Trump’s trade war is removed” –and more hedging– “if Brexit is resolved” — as if the trade war and Brexit are not effects of, intrinsic to, the accumulation of capital.

I’m a french activist and I follow your blog since 2 years. How could you concretely explain this “recovery” from mid-2016 to 2018 ? What is really a Kitchin cycle ? The IMF says there was a recovery of investment in particular in the major advanced economies. But how can investment growing again in this situation of lack of profitability ? I really don’t understand what causes this short cycles.

In effect, this is the cycle of working capital and inventories, not a cycle of fixed asset investment. So the capitalist sector can grow without any significant rise in fixed investment as it uses up spare capacity and runs up stocks or inventories. This won’t be driven by any changes in profitability. However, the cycle can only be short term – eventually stocks become too high and it is necessary to slow production to run down stocks. So we can have a short term cycle within the cycle of profit.

Quite the contrary, it is changes in profitability, specifically the relative rate of profit that drives turnover. I have made this clear in umpteen graphs based on turnover. I do not accept this cycle within a cycle.

“it is changes in profitability, specifically the relative rate of profit that drives turnover.”

No it isn’t as Marx sets out in Capital II discussing the difference between the rate of surplus value and annual rate of surplus value, and he and Engels describe in Capital III, discussing the effect of turnover on the annual rate of profit. The rate of turnover is determined by productivity, as the quantum of output required as a minimum before it can be sent to market, is produced in shorter and shorter times, and as rises in productivity in the sphere of distribution reduce circulation times.

As that raises the rate of turnover, so the annual rate of profit rises, and as Marx says, the average rate of profit, is actually the average annual rate of profit, as determined by this rate of turnover of the aggregate social capital.

There is an interesting piece by David Kotz on New Left Review September October. “In contrast to the 1970s, a declining rate of profit does not appear to have played a role in setting off the current crisis. When the 1970s crisis began, the after-tax rate of profit had fallen from its high of 11.7 per cent in 1966 to 8.7 per cent in 1973, a decline of 26 per cent. As we’ve seen, thanks to wage stagnation and business-friendly fiscal policy, the trend of the post-tax rate of profit for the us nonfinancial corporate-business sector sloped upward after 1980 (Figure 5, above). Prior to the start of the structural crisis of neoliberal capitalism, the after-tax profit rate reached a peak of 9.4 per cent in 2006 and fell for only one year, to 8.5 per cent, in 2007 on the eve of the crisis—a decline of only 9.6 per cent.”
I think you should read it, Michael.